Perfecting security interests – Part 1: Creation of the Lien
By: Trev E. Peterson
There is a lack of information concerning the way in which lenders obtain liens against personal and real property. This series of blogs will discuss (1) terminology used in the lender – borrower relationship; (2) the creation of a lien in personal property (excluding titled vehicles which will be dealt with in a later post); (3) perfection of a lien on business property and consumer goods; (4) what debt secured by the lien; (4) the effect of the lien on assets acquired by the borrower after the granting of the lien; and (5) collection on the lien. Similar topics will be addressed in the final series of blogs on liens on real estate.
First, a few definitions. Liens on personal property are generally controlled by the Uniform Commercial Code (“UCC”). Article 9 of the UCC governs the creation and perfection of liens on most items of personal property. Liens under the UCC are created by an agreement between the lender (or “secured party”) and the borrower (or “debtor”) or the owner of the personal property (the “grantor”). It is possible for an owner to grant a lien on the owner’s property to secure a loan to a third-party, such as the parents granting a lien on farm equipment to secure a loan to their children.
The lien granted under the UCC can be called either a “lien” or a “security interest.” For purposes of this series of blogs I will use the terms interchangeably. There is no functional difference between the terms under the UCC.
The reason a lender takes a lien on property is to have a lien on the property itself and the proceeds from the sale or other transfer of the property. The lien secures the lender’s loan, to the extent that the property has value. With a lien the lender is able to force the sale of the property to satisfy the debt secured by the property. In order to have a lien that is enforceable against other creditors, such as other lenders or the Internal Revenue Service, the lien must be “perfected.” Perfection of a lien generally requires the filing of a “financing statement” in the appropriate filing office. In Nebraska the appropriate filing office for most business personal property is the Secretary of State’s office. Care should be taken to be certain that the lien is filed in the appropriate office, since the failure to file in the proper office makes the lien unenforceable against other creditors or purchasers of the collateral.
The purpose of the financing statement is to put the world on notice that a lender claims a lien against the property identified in the financing statement. Subsequent lenders search the UCC records for liens filed naming the borrower to determine whether the borrower has created a lien on the borrower’s personal property. If the search does not show the existence of a filed financing statement describing the collateral that the second lender wants to use as collateral for a loan, the second lender can make the loan and once its lien is perfected by filing, the second lender has a lien on the property described in its financing statement.
The lender is required to identify the person granting the lien in the financing statement by using the debtor’s exact name. The debtor’s exact name is the name that appears on the debtor’s articles of incorporation (if a corporation), partnership agreement (if a partnership) or certificate of organization (if a limited liability company). For an individual the exact name is the name appearing on the person’s driver’s license or other governmentally issued identification. So if the borrower’s name on their driver’s license is Michael Smith, naming the debtor as Mike Smith in the financing statement may result in the financing statement being seriously misleading which results in the lender’s lien being unperfected. A failure to include the correct name does not affect the validity of the lien between the lender and the borrower, but the failure to be perfected can result in the lien being unperfected as against claims by other creditors or purchasers of the collateral and the trustee in any bankruptcy case filed by the debtor.
In addition to the name of the debtor, the financing statement has to contain a description of the property that the lender claims as its security. A financing statement could list equipment, which would cover all equipment owned by the debtor, or the financing statement could cover a specific piece of equipment, such as a ‘John Deere model xxxx, serial number xxxx”. Thus, a lender can have a lien on a specific piece or pieces of collateral or on all of the debtor’s assets.
The financing statement also has to contain the name and address of the lender. The address requirement allows subsequent lienholders to obtain information about the collateral claimed by the secured party with a recorded lien.
The next blog will discuss the creation of a lien on personal property.